Earnings Components, Accounting Bias and Equity Valuation

Peter F. Pope () and Pengguo Wang ()
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Peter F. Pope: Lancaster University Management School
Pengguo Wang: Tanaka Business School, Imperial College

Review of Accounting Studies, 2005, vol. 10, issue 4, No 1, 387-407

Abstract: Abstract In this paper we address three issues in accounting-based equity valuation: (i) How are valuation parameters related to earnings persistence and accounting conservatism when earnings components aggregate, or “add up”, in valuation? (ii) What does aggregation of earnings components in valuation imply for abnormal earnings dynamics? and (iii) When is an earnings component “irrelevant” and “core”␣earnings the relevant construct for valuation? Assuming linear valuation, no-arbitrage, dividend irrelevance and clean surplus accounting, we show that when earnings components aggregate, valuation expressions and abnormal earnings dynamics are generalizations of the Ohlson (1995) model, incorporating simple adjustments for accounting conservatism. When “core” earnings are the relevant earnings construct, valuation expressions closely resemble the aggregation case, but core (abnormal) earnings replaces clean surplus (abnormal) earnings. We demonstrate that an earnings component can be irrelevant in valuation even when it is predictable.

Keywords: Equity valuation; Earnings Components; Accounting Bias; Accounting Conservatism; Residual Income (search for similar items in EconPapers)
JEL-codes: G12 G30 M41 M49 (search for similar items in EconPapers)
Date: 2005
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DOI: 10.1007/s11142-005-4207-4

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